Asset class returns can be observed to be random.
Can anyone predict the transition month-to-month?
What is a PM to do?
Capital market returns are often viewed as random. The classic book by Burton Malkiel, Random Walk Down Wall Street, originally published back in 1973 with multiple updated editions, covers this in a readable format. How can we observe this graphically?
Callan is a well know consulting firm that publishes their annual “periodic table” of asset class returns. The table arrays different asset class returns over different time horizons against each other. In this way, you can graphically observe the rotation of returns compared across asset classes.
In the following exhibit I have plotted the monthly returns for 20 different asset classes (represented by their appropriate ETF) that cover a broad spectrum of the capital markets. Each monthly return is sorted by highest to lowest monthly return. I highlighted with arrows how the S&P 500 (light blue) and Small Cap Equity (bit darker light blue) rotated during 2019 through January 2020.
As you can see, both the S&P 500 and Small Cap Equity moved up and down the chart. As expected, the Small Cap Equity showed more movement and, thus, more volatility (RISK) than the S&P 500.
I added Apple stock (NASDAQ:AAPL) (dark gold) for comparison. As you can see, Apple stock mostly occupied the top three rows for the past thirteen months! This does not mean it does not have risk; it is just that the time horizon is too short. Likewise, Tech (dark red) occupied the top three rows over this time horizon (probably because Apple is a large component of that ETF). The same logic can be traced for the other color-coded asset classes like REITs, investment grade bonds, and emerging market equity.
Can anyone predict how these asset classes will transition month-to-month? NO! Best to be well-diversified across all the major asset classes to capture the returns when they emerge over time.
Disclosure: I am/we are long SCHA. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.